Price it right!

Whatever the product one is about to sell in any cooling market including, of course, real estate, the Seller is better off to attach a price tag that reflects the market value of the output being bought and sold. This is not only common sense but, in fact, there is a very sound economic reason behind: competition.

In Economics, price elasticity of demand is measured as the percentage change in the level of demand, that occurs in response to a percentage change in price. In general, a fall in the price of a good is expected to increase demand for that good. More specifically, price elasticity is said to be high when a small increase in price causes demand to fall substantially. An increase in price arises also in the situation wherein the general value of the commodities in an instant segment market falls. Thus, entering a market at a price level that is not in line with market value for similar goods causes demand for that particular good to drop, if its price level is even only slightly higher than the general market value.

Alfred Marshall (1842 1924) was the first to attempt to explain price behavior within the context of the equilibrium between supply and demand in competitive markets. More specifically, as it relates to inefficient markets (like real estate), the Marshallian Curve describes how prices vary as a result of a balance between product availability at each price (supply), and the desires of those with purchasing power at each price (demand). This, in turn, spurred the Marginalist Revolution, that is the idea that consumers attempt to equate prices to their marginal utility, defined as the measure of happiness or satisfaction gained by consuming goods and services. Given this measure, one may speak meaningfully of increasing or decreasing utility, and thereby explain consumer behavior in terms of rational attempts to alter prices.

The turnover in real estate markets drops when the pool of buyers ready, willing and able to consume real estate products abates. This is caused, in general lines, by two and only two factors: 1) an increase in inventory supplies or 2) an increase in interest rates. Both affect the equilibrium at which marginal utility of demand influences price behavior, according to Marshall. In this particular period, real estate markets are affected by the latter factor, that is a shift in (short term) interest rates. This is the direct and proximate result of the monetary policies of the Central Banks. By reducing the money stock, the cost to the banks for using the available capital is raised and passed on to consumers with a mark-up factor. This, in turn, discourages consumer spending on goods and services and, conversely, stimulates consumer saving. As interest rates slowly ooze upwards, demand lowers and markets cool off.

As the pool of buyers dwindles, sellers must apply leverage on the perceived value of the interest in land they are offering ,that is alter their utility so as to motivate buyers to purchase. In fact, a limited pool of buyers increases competition among sellers even if the available inventories remain unchanged. This is so, because the home-to-buyer ratio shoots up. If, for example, there is at any given time a pool of 5,000 buyers looking at an aggregate supply of 30,000 homes, the home-to-buyer ratio is 6 to 1. If the pool of buyers suddenly drops to 2,500, the home-to-buyer ratio instantaneously becomes 12 to 1.

Competition as unwelcome as it may be for some - is touted as the foundation upon which capitalism is predicated and justified. According to microeconomic theory, no system of resource allocation is more efficient than pure competition. Competition, according to the theory, causes firms to develop new products, services, technologies as well as to streamline inventories of existing products. This gives consumers better products, spurs innovation and creativity and allows for an overall greater selection. The greater selection typically causes prices for the products to fall compared to what the prices would be if there was no competition (monopoly) or little competition (oligopoly). Just like Alfred Marshall postulated some 100 years ago.

This is the reason why I said before: price it right! lest you will be the last to be served.

Luigi Frascati